INTERVIEW TRANSCRIPT: Michael Pascoe Interviews Michael Hawker

MH: We’re very happy with our results and I think the market probably underestimated, and we probably under-estimated a year ago, where our premiums were going in Australia and New Zealand. In the past six months, we’ve seen the whole market premium levels go flat, or slightly down, and I think we saw, from the QBE result two days ago, a decline in premiums in their Australian portfolios. We’ve seen them pretty flat in the past six months, so we’re forecasting the premiums in the forthcoming year are likely to be flat overall. I think the surprise was about where the whole market has moved in terms of premium growth within the Australian marketplace. Long term, we still think premiums in any market grow about a half to two times GDP. But we're in one of those phases representing some claims-cost reductions in the structural change that is driving premiums down.

MP: Work premiums too high already, or is there a bit more competition?

MH: I think there are many factors. So if we look at things like liability insurance, workers’ compensation insurance and CTP insurance, they still have falling claims frequency, which has come about through government reform. And so you’re seeing premiums following them down. In the commercial market, you’re seeing new capital come in and competition driving premiums down. I think you’re seeing in some of the other marketplaces, such as home insurance, you’re seeing slight rises in premiums because of the underlying claims cost going up because of two reasons. One is a bit more storms costing which has had an impact on a number of claims and secondly, inflationary impacts on Melbourne suppliers have pushed them up. So there’s a myriad of factors but, overall, there’s been some more reduction of premiums than there has been growth.

MP: You’ve got about a million shareholders. Would any, more than a couple of hundred, understand what you just said? Would any more than a few actually understand the business we’re investing in?

MH: I think it’s a very complex business to understand in terms of what are the real drivers of profitability. It’s a business in which we sell our product before we know the cost of it. So we get the premium today and we watch the cost manifest itself over the life of the policy that we’re writing. If it’s a motor car policy, home policy, that risk and the cost reflects itself for the next year. If it’s a liability policy, then the cost might reflect itself over the next 30 or 40 years. So there’s quite a degree of sophistication in understanding what are the short-term drivers to the profitability in these different classes. And you’re seeing a whole lot of different drivers impacting simultaneously, so it’s not a black-and-white discussion. It’s sort of saying, “Is this just competition?” There’s structure change going on. There’s competition driving premiums down. And there’s underlying claims frequency either going up or down, that are driving premiums as well.

MP: Which all makes a bit of an argument for the insurance sector being a risky thing for people to invest in, especially if they don’t really understand it.

MH: I think that the insurance industry is very structurally sound. And, because it’s a very solid cashflow-based industry, then I think it’s a very sound and stable risk. In fact, in our business, we’re double-A rated. We’re the only financial institute in Australia that is double-A rated. So the independent rating agencies view us as stronger than the four Australian banks in terms of capital strength. I think the industry is actually very strong. I think there’s volatility in earnings, but, over the long term, the aim of people running insurance companies isn’t sure that volatility when you look at it through a cycle, generates an adequate return for investors. And that’s what we’re looking to do. We’ve had two very, very good years of returns. In excess of 20 per cent returns. And we’ve had two years prior to that which were below 2 per cent. We’re trying to generate a 15 per cent return on equity right through the cycle, and that’s what we anticipate trying to do, and we think next year we’re going to have quite a solid year. However growth rates are going to be quite low.

MP: Have those two very good years also attracted more competition? Are they still coming in? Yet to come in?

MH: There’s no doubt about it. The good years have attracted more competition. The structural change put in by government reform has increased. The insurance businesses generically has stayed very disciplined about price and risk, and not gone after growth for growth’s sake. If you’re following growth, and driving price down below what’s appropriate for risk, then that seems to drive you a loss of return. And insurance companies have a long-term history of doing that, so the real discipline is to make sure that we really do write risk at the appropriate price.

MP: You wear another hat as well, as boss of the Insurance Council of Australia. Are you happy with the overall performance of the industry in Australia, or have you got members who are being a bit irrational in trying to get business?

MH: I think the Australian marketplace has been very rational. I think the increased competition is there and, like any competitive pressure, I don’t think people are at the stage where they’re pricing irrationally. I think there’s some international players coming into this marketplace thinking they’re priced rationally, but they don’t have a long history of risk in this marketplace. They might find that their price is not as rational as they thought it was. But, overall, I think the industry is in a very healthy state. We are seeing increased competition. I think that’s been good for consumers and the impact of falling premiums is great for consumers and for our customers.

MP: Another factor for an investor considering the insurance sector and IAG, wouldn't it be simpler just taking a bet on the weather?

MH: There is certainly a view out there that long-term rises in air temperatures are driving an increased frequency and ferocity of storms, and we’ve done a lot of modelling both here and internationally. And there’s quite a lot of data coming out of the international reinsurers to say the same thing, so we fundamentally believe that rising global air temperatures are driving up the cost of claims for weather events. We saw this year a $90 million higher cost of claims for weather events than last year. Last year was abnormally low, but we still saw a differential increase. From the modelling, there is a higher probability of higher wind speeds, larger hailstones and greater influence of flooding when times are wetter, so we see, over time, costs will increase. And we do think, over time, building codes will need to adapt to that.

MP: So there is a large event in the weather, particularly if you’re looking at a company involved in reinsurance?

MH: There’s a large event because the weather impacts you on an annual basis, so what we tend to do is very much try to price that risk. If the cost is going up, we very much have to write that into premiums. So what we’re saying is that the community will see this cost come through as the cost rises, so I don’t think you had taken a bet on the insurance company and what we try to do is manage those risks and we try to make sure that we’ve priced them appropriately. What we’re trying to make sure that the community understands is that we think these costs are going up and that we should be taking some steps to try and attenuate those rising costs.

MP: How’s progress on the no-fault safety net for injury claims going?

MH: There’s a lot of work going on in looking at this. A number of the state governments are working together in trying to find an alternative for no-fault catastrophic injury coverage. We’re trying to work out what the cost of that might be and there’s a lot of action working with that. There’s an inquiry going on in New South Wales and the industry has got a group of people working with the Government on trying to find a solution there.So this has been in the background for probably 18 months or two years. It requires both state and federal coalition input and it provides probably an incremental cost to all of us to pay for a slightly higher premium to cover catastrophic injury. It really is trying to understand the cost the community is willing to bear to provide a safety net for everyone in the marketplace for catastrophic injury.

MP: IAG was the insurer of the car that crashed into Fairlight Day Care Centre. Am I right in thinking that, although the driver was found not guilty of any fault, you still picked up some of the cost of that?

MH: Yes we did. We didn’t have to under legislation. We felt, however, that there was a community need in this particular case and it gave us an opportunity to help out the party that had been impacted by our customer, the driver. We worked to make sure they were comfortable with what we were doing. It also gave us an opportunity to raise the issue of this whole no-fault claim issue within government circles and to point out some of the inequities in how no-fault claims were occuring. So it really was an opportunity for us to do the right thing for the injured party and for our customer and really point what we think are some of the scheme deficiencies.

MP: Because there was an accident that didn’t occur on the road, CTP wasn’t involved?

MH: No, CTP was involved, but the only way that you can get some compensation from the CTP claim is if you can prove that the driver was negligent, and in his case that wasn’t found, so you have some young kids who were severely injured who we essentially said we’d like to do something for even though we didn’t have that requirement as an insurance company to do that.

MP: Was that assistance of the order of what you imagined a safety net catastrophic injury claim may pay out?

MH: Oh, it’s very hard to put a value on it, because I think, at the end of the day, to find the right safety net is a balance between what the community feels is appropriate to pay for that safety net and the value that then comes out from that safety net.

MP: Is there an argument to extend it beyond CTP and workers compensation, and other catastrophic injuries that occur?

MH: I think that’s something that government is interested in looking at, and they’ll put it to the community to see whether the community think that’s appropriate.

MP: But it’s not one that the Insurance Council is leading the way on?

MH: We’re certainly having discussions with the governments about that. So, we’re actually looking at catastrophic injury right across the community and seeing whether there is a model of saying that, if rather than paying it through taxes, people pay a specific levy through their insurance policies that covers catastrophic injury.

MP: I’ve asked you about this before in other interviews. Is it still an unforeseeable distance away from happening?

MH: That’s difficult to answer. I think there’s a lot of goodwill at the moment within the insurance industry and government working together to try to create an outcome. There’s certainly a lot of people working in the actual health professions trying to determine what the scheme might look like. Whether it’s feasible or not will be a function of our academic work and the mathematical modelling, and an assessment of whether that can be instituted nationally on a state-federal basis.

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